8 financial reporting errors — and how to fix themThe best accounting software available won't produce the best financial reports if the reporting process is flawed. Here are some pitfalls to avoid.
The financial reporting process is considered by many to be the single most important function of an accounting system. However, even the best accounting system can't overcome a flawed financial reporting process.
To help you determine if your financial reporting process has a problem, start by answering these five questions:
- Does your accounting or enterprise resource planning system produce accurate monthly financial reports on a timely basis, ideally by the tenth day of the following month?
- Are all appropriate financial and informational reports produced on a daily, weekly, and monthly basis?
- Are those reports distributed in a timely fashion to the appropriate personnel (either on paper or digitally)?
- Do the appropriate personnel know how to read the reports and understand how to use the information contained within those reports?
- Do these personnel take time to read the reports and use the information and insights derived accordingly to better perform their jobs?
Answering "no" to one or more of these questions indicates that work is needed to shore up your reporting processes. Following is a list of common mistakes companies make related to their financial and informational reporting functions, and suggestions for avoiding those mistakes in the future. While some of these steps may seem basic, many companies struggle with them, and all companies should double-check to ensure they are handling them correctly.
1. Financial reports lack comparative data
Some companies may produce only single-column reports, which are less informative than multi-column reports due to the absence of comparative data. The inclusion of prior-year amounts, prior-month amounts, or budgeted amounts makes it easier for the reader to ascertain whether current amounts exceed, or fall short of, expectations.
Solution: Be sure to include comparative data in your financial statements and informational reports. Rather than squeezing every possible comparative figure into a single report, which might result in too much information, consider issuing multiple reports instead. For example, you might produce two income statements — one comparing actual amounts to budget amounts and the other comparing actual amounts to prior-year amounts.
2. Financial reports lack calculated differences
While the inclusion of comparison columns (as mentioned above) is a step in the right direction, the absence of difference calculations forces the reader to calculate those differences mentally or with a calculator — both methods of which are time-consuming and more prone to error. The more efficient approach is to provide readers with calculated column differences so they can focus more on studying the data, and less on the arithmetic.
Solution: When producing financial reports containing comparison data, include calculated differences so the reader can more easily digest the data.
3. Financial reports lack calculated percentage differences
Where difference calculations can be informative, percentage differences can be equally or more informative. For example, assume that the budgeted and actual amounts are $62,000 and $74,000, respectively, for salaries expense and $2,800 and $5,600, respectively, for utilities expense. In this simplified example, the calculated differences show that the actual salaries expense exceeded the budgeted amount by $12,000, while the utilities expenses exceeded the budgeted amount by only $2,800. In this situation, a casual reviewer might focus on the larger salaries difference and downplay (or overlook) the excessive utilities expenditures. However, the percentage difference calculations for these same amounts reveal that the salaries expense is over budget (or unfavourable) by 19%, while the utilities expense is over budget (or unfavourable) by 100%. These additional percentage calculations make the utilities overruns far more difficult to overlook. The table "Displaying Percentage Calculations" shows these expense amounts, including the calculated differences and percentage differences. Notice how the (12,000) and -100% difference amounts are easier to detect (or catch), as opposed to reviewing the actual and budget columns only.
Solution: When producing financial reports containing comparison data, include percentage differences with the calculated differences so the reader can more easily catch overruns that may not be as noticeable when analysed purely on calculated differences.
4. Financial statements don't reflect reality
On occasion, I ask my small business clients' bookkeepers whether the financial statements are accurate. Almost always those bookkeepers respond "yes". However, if I pick out specific amounts from those same financial statements (such as an accounts receivable amount of $38,200, an inventory amount of $123,450, or a cash in bank amount of $86,560) and then ask if those individual figures are 100% correct, on occasion, those same bookkeepers respond, "No, those amounts are off a bit," and they then proceed to provide explanations similar to the following example: "Our customer, Mr. Thomas, received some broken items, so he's returning about $6,000 in merchandise; therefore, accounts receivable should actually be closer to $32,200, not $38,200. Further, the owner hasn't cashed his owner draw checks for the past three months and doesn't plan to cash them. Therefore, the bank checking account balance should be closer to $116,560."
My point is that in some cases bookkeepers (and usually others in the organisation) think it's acceptable if the financial reports don't reflect reality, so long as the relevant personnel are aware of the report's discrepancies. Unfortunately, many small business bookkeepers are not trained in proper revenue and expense recognition principles, and as a result, they don't always produce accurate financial reports. This type of situation results in inaccurate financial reporting, which, in turn, leads to management potentially making important financial decisions based on the data contained in those inaccurate reports.
Solution: Bookkeepers, managers, and company officials should be trained in proper accounting methods, including proper revenue and expense recognition. In addition, consideration should be given to training these personnel in common auditing procedures to help them better understand the goals of producing financial reports that most accurately reflect reality. Until such training is completed, proper third-party review procedures should be established to ensure that an accountant who has the right experience reviews the company's reports.
5. Failure to read/study/scrutinise financial statements
The process of producing financial reports is almost pointless if no one bothers to read or study those reports. Further, it's also rather pointless for personnel to read or study those reports if they aren't going to investigate significant deviations or suspected problems or errors.
Solution: Everyone who receives financial statements or informational reports should:
- Be trained in how to read and understand those reports.
- Take time to read and study those reports in a timely manner.
- Identify discrepancies (in the report's data, amounts, or balances), if any, that deviate significantly from expectations.
- Attempt to determine the cause of those discrepancies and address them to everyone's satisfaction.
- If discrepancies cannot be explained, escalate those discrepancies or data anomalies to someone who can adequately address them.
6. Failure to revise procedures to prevent discrepancies from recurring
Often companies that identify an error or discrepancy appropriately take time to adjust or correct the books but then fail to implement or revise their accounting procedures to prevent the error or discrepancy from happening again. For example, if a discrepancy results from improper processing of a complicated customer deposit, the error should be corrected in the accounting system, and a second party should be assigned to review all complicated customer deposit transactions in the future until the bookkeeper who made the error is deemed proficient in this activity.
Solution: As significant deviations are identified and corrected in the system, management should implement corrective measures to ensure that the discrepancies don't recur.
7. Failure to calculate and analyse financial ratios
Analysing one's balance sheet ratios can help ferret out troubling trends that may otherwise go unnoticed. For example, if your number of days in accounts receivable grows from 26 to 28 to 34 over a three-month period, it could be a sign that some of your customers have impending cash flow problems, or perhaps it means that your accounts receivable staff are falling behind on their collection responsibilities. As a second example, if your calculated days in inventory grows significantly over a few months, it could indicate that your purchasing staff are over-ordering merchandise or, perhaps, that your production operations are slowing down. Depending upon your industry, there are myriad balance sheet ratios and calculations that, when compared to prior months or industry standards, might suggest problems that need management's attention.
Solution: Attach charts plotting relevant balance sheet and income statement ratio calculations to your monthly financial statements and reports to help readers fully understand the results of operations, as shown in the chart "Days Inventory Outstanding".
8. Failure to prepare perpetual cash flow forecasts
Because cash flow is such a vital part of a company's operations, cash flow forecasts should be prepared and updated periodically (either monthly or quarterly, for example). To prepare a proper cash flow forecast, companies must first prepare a seasonalised monthly income statement budget and a projected monthly balance sheet. Projected balance sheets can be calculated using data from the seasonalised monthly income statement budget in combination with historical balance sheet ratios (assuming those balance sheet ratios are consistent enough for such purposes). Once completed, the cash flow report should be updated each month to reflect actual values for the most recent month (or quarter), and the remaining projected cash flow values should be adjusted accordingly, if necessary. Using a proper cash flow forecast report, companies can better manage cash investments to maximise investment earnings, plan for sizeable expenditures, or anticipate cash shortfalls early enough to enable company officials to obtain working capital loans to help weather low cash flow periods.
Solution: Be sure to prepare seasonalised income statements, projected balance sheets, and projected cash flow forecasts, and then update the cash flow forecast monthly, as necessary.
J. Carlton Collins, CPA, is an accounting systems consultant, a continuing professional development conference presenter, and an FM magazine contributing editor. To comment on this article or to suggest an idea for another article, contact Jeff Drew, an FM magazine senior editor, at Jeff.Drew@aicpa-cima.com.